Uncertain Global scenario may lead to turbulence in equity markets

I have been cautioning investors about the risks in Indian markets over the past few months. Equity markets have corrected substantially to the levels of 7900-8000 on Nifty, which I had anticipated. However, our markets have not factored in all the immediate global risks and the negative impact of 'Demonetization'. So where are the markets headed in the next few months from now on? Let us try to find the answer to this question.

Global research houses are now coming up with their revised estimates for India's GDP growth, and most of them have painted a rather gloomy scenario. There have been serious downgrades for GDP estimates for second half of fiscal 2016-17. As equity investors always take a forward looking bet on the markets, they are likely to take a bearish view in the near term. The 2 most important factors that stunned the markets in November (Modi's Demonetization & Trump's victory) would continue to drive the fortunes of our markets in the medium term.

International Factors:

• US Monetary policy action of raising interest rates has led to the strengthening of US Dollar. The Dollar index has risen beyond 103 and is likely to test 105 in the short term, putting pressure on inflows into emerging markets
• After several rounds of negotiations OPEC and non-OPEC countries have arrived at a consensus on cutting global oil output, leading to a sharp uptrend in Crude oil prices. Crude is like to head towards $60-65/ barrel, which is negative for net importers like India
• Protectionist stance by global leaders: Britain & USA may impose restrictions on overseas workers leading to a shrinking in global trade, which is negative for countries like China & India

Domestic Factors:

• Economic activity has slipped to multi-year lows, leading to a sharp decline in GDP growth for next couple of months. India may clock a GDP growth of 5.5-6% for FY 16-17, a sharp decline over the previous year
• Large scale unemployment in SME sector and Rural sector will put adverse pressure on consumption demand from the rural markets, leading to a big blow to our 'consumption theme'
• Rupee would continue to decline, leading to further exodus of FII money from our markets. FIIs would take any new bets on emerging markets only after January 2017, after Donald Trump takes over as US president on 20th January
• There is also a likelihood of an escalation in Indo-Pak hostilities across the border, adding to the economic uncertainty.

Considering the above factors corporate earnings of India Inc. are likely to grow by a meager 2% during FY 2016-17. The markets are likely to take the final plunge sometimes in January 2017, after the inflow of Corporate results for Q3 ending December 2016. The markets may react to levels of 7500 or lower on Nifty during that period. But due to the 'Spring effect' we could see a U-shaped recovery thereafter. The upcoming Union budget to be announced on 1st February 2017 could prove to be a game changer for the markets. Investors are advised to buy aggressively in the 7500-7700 range on the Nifty to lock in handsome gains during the next year. Long term investors should continue to hold on to their investments in the market mayhem.

Demonetization demystified: A 'Hormegeddon moment' for Indian economy

A fortnight has passed since 8/11, when PM Modi announced the 'Demonetization' of Rs.500/1000 currency notes, a step that has been hailed by many as a 'bold initiative' and 'catastrophic disaster' by others. While I fully support the PM's crusade against black money, corruption and counterfeit currency, I would like to analyse the issue of 'demonetization' from the perspective of an Economist. "Hormegeddon" is a term coined by entrepreneur and New York Times bestselling author Bill Bonner to describe 'How too much of a good thing leads to disaster'.

Demonetization is the act of stripping a currency unit of its status as legal tender. In order to understand the effects of demonetization let us have a peep into history. Demonetization has been tried by several countries in the past to meet the under noted objectives:

• To take out of circulation higher/ lower value notes that have become redundant
• To reduce Govt. debt and reduce inflation
• To remove counterfeit notes in circulation
• To curb parallel economy and illegal trade

In 1969, Richard Nixon, the then United States president, had, in one go, demonetized $10,000 and $1,000 bills. He kept only $100 as legal tender, which achieved its stated objective. But demonetization attempts by Ghana in 1982 and Nigeria in 1984 failed miserably as these debt ridden economies collapsed after demonetization. In 1987, Myanmar’s military invalidated around 80% value of money to curb black market. The decision led to economic disruption which in turn led to mass protests that killed many people. The demonetization that happened in North Korea in 2010 left people with no food and shelter. Mikhail Gorbachev ordered to withdrew large-ruble bills from circulation to take over the black market. The move didn’t go well with the citizens which resulted into a coup attempt which brought down his authority and the led to Soviet breakup. 

Several countries in the past have taken up demonetization drive. but those exercises were too small in nature. India also attempted demonetization in 1978 under PM Morarji Desai when Rs.1000/5000/10000 notes were banned. However, at that time the notes banned formed a minuscule 3% of the total currency in circulation. The present demonetization drive in India is unprecedented and biggest in the monetary history of modern world, as it attempts to take 86% of the issued currency out of circulation. The most acceptable argument in favour of the recent move seems to be a strike against counterfeit notes which have been widely used for terrorist funding. As far as black money is concerned about 97% of the black money generated in India is parked in foreign accounts, real estate and precious metals (gold & bullion), and only 3% may be held in the now banned currency notes. As per RBI estimates out of total currency notes issued worth Rs.1754000 crores, 86% are in denominations of Rs.500/1000.

The immediate likely advantages of this move are:

• A size able curb on Hawala trade from across the border, a big blow to terror funding in India
• A huge surge in liquidity for the banking system, paving the way for lowering of lending rates
• A one time windfall gain of around Rs.3,00,000 crore for the Govt. (in the shape of notes not getting deposited in the banking system), leading to lowering of Govt. fiscal deficit.
• A drastic fall in inflation due to scarcity of money.

Now let us analyse the disadvantages of this move:

India has been billed as the fastest growing economy in 2016-17, which resulted in it getting the status of the most favoured destination for foreign investment. Demonetization will lead to a major dent on our growth prospects leading to a catastrophic effect on future investments in India. The major ill effects are listed below:

• India's GDP is expected to shrink by almost 50% during the second half of fiscal 2016-17. Our GDP estimates for the whole year would be revised downwards to 5-5.5%.
• Indian economy adds approx. 1.2 crore people to the job market every year. With the shrinkage of economic activity most of these people would add to the unemployment stream, leading to widespread discontent.
• The capacity utilisation of the Corporate sector which is already at a low of around 63% is likely to dip further, leading to a fall in turnover and employment generation.
• The likelihood of small business sector taking a major hit are very high. This may lead to closure of several businesses leading to widespread unemployment and higher NPAs for banking sector.
• The shoddy implementation of the scheme is already adding to the woes of the underprivileged sections of the society, especially the daily wage earners.
• The political deadlock over the issue is causing delay over several important legislation, like GST, which is likely to get postponed by one year. 
• The cost of replacement of 86% of the currency is going to be pretty high, although RBI has not given any figures yet.

How far the Govt. is capable to cope up with these challenges will determine the success or failure of this exercise, till such time the patience of millions of honest/ law abiding citizens of our country shall be continuously put to test.

Investors fasten your seat belts: The D-Day has arrived!

Investors across the world are on their tenterhooks as US awaits the announcement of its 44th President. There has been a lot of discussion/ speculation around the world as to who is going to be the next incumbent to the White House. But from an economists' point of view it is hardly significant on who occupies the coveted position, as it is certain that the next incumbent would have to sign the obituary of the current 'Super Power' of the world. 

Believe me, the US economy is in shambles and the outgoing President Barak Obama must take due credit for this sorry state of affairs along with the Federal Reserve of the US Govt. In response to the faulty economic policies followed by the Obama administration, FED has been printing money to be distributed amongst the borrowers at the cost of the savers. This policy can be termed as 'rich getting richer'. US GDP growth during the eight years of the Obama administration averaged half the rate of the Clinton years and only one-third the rate of the Kennedy and Johnson years. The FED has followed a Zero interest rate policy for the past 8 years and is still shy of reversing it, but this artificially managed rate is no longer sustainable. When the US moved away from the Gold backed US Dollar standard in the early 70's, its credit to GDP ratio was 1.5:1, today it has shot up to 3.2:1. The new US President would have to address this anomaly, and the chances of declaration of a 'Financial Martial Law' in US are extremely high.

Thus, whom so ever wins the November 8 election, the markets around the world are likely to slip into a 'Coma' for a while before they are able to appreciate the reality. The next 2 months are going to be extremely volatile for the markets, as the transition of power in the US is not going to be a smooth affair. Things are likely to settle down only after the new President assumes office in the middle of January 2017. It is not going to be easy for the new President, as he would also have to prepare for transfer of the 'Super Power' baton to another nation. Who the next Super Power would be, will be decided in the next couple of years, but China seems to be a front runner for the crown, provided it is able to address its growth issues, which have taken a temporary beating.

Post the results of the US election, US markets would almost certainly lead to a fall in the markets worldwide, they could correct anywhere between 10-20% during the course of next 2 months. Investors in India are advised to tread cautiously during this period, as there is a likely hood of heavy FII outflows during this period. But at the same time it would provide a good opportunity to enter the market on declines, as India is on the cusp of a sustained bull run due to 2 major favourable factors: Low crude oil & commodity prices and a low interest rate regime. Indian markets could turn attractive after a 5-6% fall from hereon, that is around the levels of 8000 on the Nifty, when the risk-reward ratio would turn attractive. Mid Cap and Small Cap indices could go down more during this period, after their recent dream run.

Uncle Sam faces grave 'Economic Crisis': Will it go the Russian way!

While going through the history of 'Business cycles', we stumble upon an interesting fact: An 'economic crisis' or 'recession' repeats itself every 7-8 years on an average. Consider the historical evidence: Ever since the 'Great depression of 1931', the world has undergone a crisis situation at regular intervals. The last two crisis are still ripe in our memory: The crisis of 2001 (known as 'Dot-com bubble'), and the 2008 crisis (known as 'Sub-prime mortgage crisis'). This theory points towards another impending crisis in 2016-17. 

With the stock markets world over in the midst of an unprecedented 'Bull run', it is virtually unthinkable that a crisis is coming. So I had to brush up my knowledge of history to pin-point from where this crisis would emanate: Would it be Greece, China, Britain or any other country. The financial markets have braved all the negative news: be it failure of Greece, China's slowdown, Brexit or continuing recession in Japan, but will they be able to absorb the biggest shock that is knocking at our doorstep. Let me tell you a breaking news: 'Uncle Sam aka USA is broke' and will lead the crisis of 2016. I have been consistently warning my readers that the markets are over-heated, but the markets have continued to defy all logic in the recent past. I am happy that now people are giving heed to these sane voices. Here are a few statements, about American markets, recently made by some famous market experts:

•  “A $68 trillion ‘Biblical’ collapse is poised to wipe out millions of Americans.” - Jim Rogers
•  “Investors are on the Titanic” and stocks are about to “endure a gut-wrenching drop that would rival the greatest crashes in stock market history.”  - Marc Faber
•  “U.S. stocks are now about 80% overvalued.” - Andrew Smithers
• “Sell Everything” because “in a crowded hall, the exit doors are small.” - Royal Bank of Scotland

These American seniors have been worried about their nation's ability to pay out social security. Let us understand the reasons for their grave concerns about the future of American economy:

1. US is staring at mind boggling debt of $19 trillion, and an unmanageable fiscal deficit of $200 trillion
2. Inflation and Falling Real Wages: Retail inflation is higher than the figures declared by the Federal Govt., leading to an erosion in the real wages earned by a majority of Americans
3. American's have little or no money set aside for emergencies. According to a survey almost half (47%) said their savings would cover their living expenses for 90 days or less
4. The Federal Reserve’s fund rate has been coming down for more than 30 years, any hike would cripple the budget of an average American
5. US companies are increasing relying on foreign sales for survival, with global recession looming large these companies will find it hard to remain profitable
6. With the west losing its supremacy in the global sales, the world is looking with suspicion at US$ as the 'Reserve currency'. The recent decision by IMF to declare 'Rem nimbi' as an additional Reserve currency will add to the woes of US$.

These conditions are pointing towards a grim reality: The crash of US$ and the US stock market. To avoid this catastrophe US Federal Govt. may impose a 'Financial Martial Law' to shore up its resources, which means bad news for American citizens. At the same time US is also facing two more challenges: The US presidential election (The campaign so far has been reduced to a non-serious business with personal vendetta to the fore and major issues in the back-ground), and the chances of a full fledged war with Russia over Syria - as Russia has decided to challenge any diktat from USA or the NATO. Financial Emergency was last invoked in USA by President Nixon in 1973.

Will USA go the USSR way? The answer is 'No', because USA has a Federal Structure where states enjoy sweeping powers, and the US President is 'All Powerful' in the sense that he can be ruthless with the enemy as well as its own people in times of 'Emergency'. USA has enjoyed the status of the 'Sole World Super power' ever since the end of the cold war. But if the simmering discontent among the common US citizens spreads to the streets it may pose a serious threat to the Presidential form of Govt. in its present form. Will USA come out ever stronger as it did after the 'Nixon shock' of 1973, or will its supremacy as Sole World Super power threatened, and Barak Obama going  down in history as the last strong US President? Only time will tell, but the world is definitely moving towards a tectonic shift in the 'Balance of Power'.

Based on the above, my prognosis is: USA will lead the world into a deep economic crisis sooner than later. Investors are advised to reduce their holdings in risk assets like equity and real estate, and focus on alternate investments. An increased proportion of Debt and Gold in the portfolio would be a better option. If US markets are expected to crash by 30-40% as per estimates of analysts, Indian equity markets would also bear the brunt, although to a lesser extent,

Markets enter a short-term downtrend: Prepare for 'Bargain Hunting'

Indian equity markets have got the trigger, which they were looking for, to start an intermediate downtrend in the garb of 'Surgical strikes' by our armed forces in 'POK'. As pointed out earlier, our markets had moved far ahead of fundamentals, and a meaningful correction was long overdue. The correction is now underway and we may witness the markets sliding gradually to reasonable levels during the course of next 2 months or so. But at the same time it would be prudent to be flush with cash, as there would be opportunities galore for picking up blue chips at 'bargain prices'. As the festival season unfolds in India, companies would be launching mega sale of their products, similarly this year stock markets would also be offering bargain sale of blue chip shares of companies for the long term investors.
Those of you who have booked profits in shares, as advised in these columns earlier, can enjoy the festivities with purchase of your favourite products or take a dream holiday to your favourite destination. But do keep some profits aside to be re-invested in equity markets as they correct reasonably to give a better risk-reward ratio to long term investors.
Let us analyse the factors that are responsible for the on-going correction in equity markets. Let us first analyse the 'Geopolitical risks' prevalent in the world at this juncture:

• The diminishing role of US in the world affairs, will lead to escalating conflict in the middle-east, with Russia playing the role of a spoiler.
• Post 'Brexit' a closed Euro zone will face an enormous challenge grappling with the twin problems of economic stability and refugee influx due to terrorism.
• The economic instability in China looms large as it grapples with the 'Debt bubble' which could have far reaching consequences for the global economy.
• The 'Oil shocker' could escalate the war for supremacy in the middle-east, especially after lifting of sanctions against Iran, and its competitive stance against Saudi Arabia.
• The US presidential elections would keep the world on its tenterhooks till November, as it unfolds into a swinging battle between Hillary Clinton & Donald Trump.

India specific issues:

• Most positive news has already been factored in: A near normal monsoon & the effect of the 7th Pay commission arrears on consumption and inflation. The markets may get a temporary bump up if RBI announces a surprise rate cut in its October 4 policy, but it would be short lived
• Tensions across the border would give the markets enough jitters, leading to an increase in volatility.
• The 3rd quarter results may again prove to be a dampener, as most companies continue to be weighed by excessive debt, with no signs of demand pick up except in a handful of sectors.

The above factors indicate that the markets may have entered into a short-term corrective phase which may last for about 2 months, and the price correction has the potential to lead to a substantial correction in the indices: I would be comfortable with a Nifty level of around 8000 to commit fresh funds for long term. This would be the level around which I would advise investors to seek 'bargain hunting' in accumulating blue chips for the next bull run on Indian bourses.

Equity markets are overheated: Do not reflect Economic fundamentals

Indian equity markets have entered a danger zone, and a severe fall can not be ruled out once global liquidity dries up. Equity markets made new highs today with Nifty touching 8800 during trading hours. Markets seems to have discounted all the good news, however, seem unconcerned about the impending domestic & global concerns at this juncture. Most of the analysts are misleading the common investors by giving absurd targets for the indices in the days to come. I would like to caution the investors about the challenges faced by the global economy, which are likely to have an adverse impact on our equity markets.

Domestic issues: The GDP figures for the first quarter of this fiscal, released in the evening, have exposed the weakness of the economy. GDP for Q1 has slipped to 7.1% as compared to 7.9% for the previous quarter (Q4 of FY 2015-16). Industrial growth is down to 6%, Agricultural growth is down to 1.8%. The day has been been saved by Service sector growth at 9.3%. More worrying news comes from the Fiscal deficit front where the Govt. has reached 73% of the budgeted target within the first 4 months of the year, implying that it will exceed the Fiscal deficit target by a huge margin. Despite passing of the GST bill, the Govt. is not fully prepared for its roll-out from April 2017. The prediction for an above normal monsoon had been discounted by the market, but the progress of monsoon reveals that its distribution has not been up to the mark. The markets are again irrational in discounting the impact of  'Arrears paid to Govt. employees' as the same is likely to be inflationary in nature.

Global scenario: The global markets are flush with stimulus funds which are driving equity markets to crazy levels, far ahead of fundamentals. I would like to mention 3 inflection points which would lead to a negative slide in our markets:

1. Interest rate hike by US Federal Reserve: The oft postponed rate hike is now inevitable, it is likely to be announced in September. This will lead to strengthening of the US $, leading to the flight of capital from equity markets to safe havens like US treasuries, Gold & Silver. It would also have a negative impact on our already shrinking exports to developed markets

2. Impact of Brexit: As euro-zone prepares for Britain's exit, the instability would lead to drastic cut in Capex budget in the euro-zone and consequent decline in IT exports to these countries from India. New regimes in UK and US are seen moving toward stringent immigration laws, leading to a fall in global Indian companies operating in or supplying to these countries.

3. Financial turmoil in China: China's growth has been an enigma for the entire world, but now the cat is out of the hat. The next round of global instability is likely to be inflicted by China, as the country's debt has been mounting to unreasonable levels. China may resort to further devaluation of its currency to stem the rot, but it may have a cascading effect on developing markets, and India is unlikely to be spared.

In such a scenario our equity markets will need to correct substantially, to make them reasonably priced (Nifty index currently trades at a PE multiple of over 23, as against the average of 14-16). Nifty index has had a non-stop run from 6825 to around 8800 within the past 6 months. A reasonable correction from these levels would take the Nifty in the range of 7800-7900 levels (a 50% retracement of the recent rise). Investors are advised to book substantial profits at the current level, and wait for a correction to around 8000 levels on the Nifty to re-enter again. The fall in Mid-cap & Small-cap stocks could be much deeper.

India's GDP Growth: Myth & Reality

If statistics are to be believed, Indian economy has become the fastest growing economy in the world, raking in a GDP growth rate of 7.6% in FY 2015-16. What is even more shocking to digest is the GDP number of 7.9% for the 4th quarter ended March 2016. Many economists are scratching their heads in disbelief at one of the biggest 'economic fraud' of the Govt. of India. A section of media and the crony capitalists may be singing praises for the Govt., but the figures simply do not add up. Here are some bitter facts about the real economy:

• 2/3rd of the population living in rural India continues to be in extreme distress
• Salaries may have gone up in urban India, but high food inflation is keeping the folks unhappy
• Even the benefit of low crude oil prices has not been passed on to the people: Petrol is back at Rs.70 a litre
• Most corporate houses are shying from fresh investment as the profit margins have shrunk to multi-year lows
• Bank's have been unable to pass on the benefit of low interest rate to the population as they are grappling with the worst NPL crises.
• Exports, imports and remittances from abroad are sharply down
• The manufacturing PMI of 50.7% for May 2016 is the lowest in the past 5 months
• Growth in public spending, which should act as the key driver of growth, marked a sharp drop by 5.4% in fiscal year 2016 
• Employment growth plunged to a six-year low in 2015 across the eight key labour-intensive industries and only 0.1 million jobs were created last year.

The above data highlights the real report card of the present Govt., at a time when it is celebrating completion of 2 years in office. The Govt. has failed to provide any economic stimulus during the past 2 years. Private consumption has been calculated to have grown by a whopping Rs.1,27,000 crores without any evidence supporting the figures. Many economists argue that there are anomalies in the new series of GDP estimates released in January 2015. As per the old methodology Indian economy may have barely grown by 4%, or half of what has been reported recently. The economic jugglery or the biggest 'data fudging' may soon be questioned at international forums, and India may risk a downgrade in its sovereign rating.

There are 3 main culprits responsible for India's current dismal economic situation:

1. Arun Jaitley, FM: A man without a political stronghold, who never won an election and yet catapulted to the position of FM, he has failed to handle the situation effectively, despite the windfall received due to the crash in global crude oil prices. During his tenure rural demand has slipped to its lowest ever, and consequently fresh investment has struggled. He may turn out to be the most incompetent FM India ever had.

2. Subramaniam Swamy: The loose canon of BJP, who has prepared the ground for passing the buck of Govt's economic failure at the doorstep of the RBI Governor. The man chosen by BJP to counter the Gandhi family may turn out to be an embarrassment for the party.

3. TCA Anant, CSO: For doing the data fudging at the behest of his masters, Modi and Jaitley.

The Govt. may be relying heavily on the better monsoon forecasts for the current year for a turn around in its fortunes, but there are far too many other factors like the distribution pattern, which play an important role in the overall impact of the monsoon on the economy. Relying merely on a single factor for a turn-around could be asking for further trouble. A lot needs to be done by the Govt. on the economic front, before it is too late, they need to compensate for the uneventful first 2 years in office.

Equity markets on 'Tenterhooks' on Financial sector flip-flop

The short term recovery in our equity markets that brought the Nifty close to the 8000 mark, failed to sustain as Financial sector outlook remained uncertain. Nifty did make a smart come back from the levels of 6825 touched on the budget day, but the status-quo announced by Bank of Japan (BOJ) on quantitative easing took the wind out of the markets. On the other hand, weakening of the dollar (after taking ques from BOJ) stretched the rally in gold as the precious metal traded close to the 1300$/ ounce mark. We have seen a sharp decline in global equity markets towards the end of the month. Our markets have other issues to digest beyond the weak global signals.

The most important question for our markets is the Health of our Financial sector. The dilemma before the analysts is to decide whether the declaration of bad loans in the balance sheets of Banks (responding to the dictat of the Central Bank), and the corresponding hit on the bottom line, a positive development or it should be treated as alarm bell for the health of the Financial sector. As at the end of December 2015 the gross NPAs of 39 listed entities of the banking sector amounted to over Rs.4.38 trillion. And a staggering Rs.6 trillion is classified in the categories SMA 1 & 2, a portion of which will definitely find its way to the NPA category over the next financial year. 

To add to the woes of the Banking sector is the alarming situation existing vis-a-vis NBFCs (there are over 11000 NBFCs registered with RBI). As per RBI's report on NBFCs, where the norms for NPAs are less stringent as compared to banks, they have 3.5% bad assets on their books. The sectors contributing towards the stress assets are: Infrastructure, Steel & Power to name a few. 

With the economic revival still at least 2-3 quarters away, the stress on the books of Financial sector companies is only going to escalate before it begins to decline. Given the acute drought situation prevailing in the country, something more that an above normal monsoon will be needed to help the Financial sector overcome its current set of woes. The equity markets have perhaps sensed the alarming situation, and are likely to remain subdued in the immediate future. A marked improvement in the market fortunes is linked to a meaningful turn-around in the health of the Financial sector.